Results

• Inline: 9M16 net profit of RM431.9m accounted for 68.0% and 62.5% of ours and consensus’ full year estimates. Adjusting for the one off restructuring expense of RM85.7m in 2Q16, core profits would be above ours but in line with consensus estimates.

• We deem this to be in line as we expect the subsequent quarters to remain challenging on the back of record high illicit market share of 49.9% as of Wave 1, 2016 illicit study vs. 36.9% in FY15.

Dividends

• Declared third interim dividend of 55 sen/share bringing YTD dividends to RM1.55/share (9M15:RM2.34 sen/share), representing a payout and yield of 102.4% and 3.0%.

Highlights

• Volume: BAT’s domestic and duty free and contract manufacturing volumes continued its downward trajectory, declining by 30.0% and 41.9% YTD vs SPLY. The decline in domestic volumes can be attributed to affordability issues resulting from the previous excise revision and upsurge of the illicit market as a consequence.

• Contract manufacturing volume decline is in tandem with the group’s restructuring and cessation of its manufacturing business as well as lower demand from export markets.

• Financial performance: YTD, the volume decline subsequently resulted in revenue declining by 17.2% yoy. Bottom-line contracted by 39.6% yoy (-27.6% yoy excluding EI). Qoq revenue declined marginally by 3.2%, whilst core net profits increased by 32% due to lower depreciation and tax expense on the back of reversal of the over-provision for tax expenses from the previous quarter.

• BAT’s market share of the total legal market as at August decreased by 2.8ppts to 58.1% vs full year 2015. This is attributable to the down trading environment, and the group’s portfolio skewing towards premium brands.

• The net sale of proceeds from the disposal is to be utilized as a special dividend to shareholders to be paid in March 2017 with the 4Q16 dividends. Our pro forma calculation implies that a special dividend, of up to RM1.19 sen/share, yielding up to 2.3% resulting from the disposal exercise.

• Whilst management believes that volumes are exhibiting signs of stabilization, we are still cautious on the volume trend despite the restructuring of tobacco distribution on the duty free islands. We understand that the bulk of the contraband cigarettes found in the domestic market are from shores further away from our islands.

Risks

• (1) Exceptionally higher excise duty hike; (2) Increase in illicit trade volume; (3) Weaker-than-expected TIV; and (4) Regulation tightening. (5) Vaping Industry.

Forecasts

• Unchanged.

Rating

HOLD ↑

• Share price has retraced circa 30% from a peak of RM70 and a special dividend of up to RM1.19/share bringing potential total dividend yield to circa 6-6.2% is on the cards. In light of this we upgrade to a HOLD.

Valuation

• Maintain TP of RM45.55 based on DCF (WACC: 8.2%; TG 3.0%)

Source: Hong Leong Investment Bank Research - 25 Oct 2016